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Banks plan further market intervention

Central banks are preparing to launch fresh interventions in money markets this week to avert a full-blown credit crisis, following warnings by US analysts that up to $300bn (â‚¬219.8bn) of loans could be jeopardised.

This follows a $300bn cash injection by the European Central Bank, US Federal Reserve and other central banks last week into the banking system, after financial markets plummeted on fears of a looming credit crunch. Banks, hit by sudden and unexpected losses from bad loans in the US mortgage market, suspended normal lending.

Fresh US estimates suggest that the amount of loans at risk could be far greater than thought. Christopher Whalen, managing director of Institutional Risk Analytics, which builds risk systems for regulators and auditors, said there was between $250bn and $300bn at risk in collateralised debt obligations.

In London, the Financial Services Authority is in constant touch with leading institutions, assessing the extent of their exposure to asset-backed securities. In recent months the FSA has been urging banks to 'stress test' their portfolios. The UK regulator is 'reasonably comfortable' that the London markets are robust enough to withstand further volatility.

The FSA believes that while the emergence of complicated financial instruments makes it harder to pinpoint precisely where the risk is, it believes that it is widely dispersed, so making it is less likely that a large-scale institution could be vulnerable to collapse.

Panic selling by hedge funds has emerged as the hidden cause of the contagion spreading through the global financial system.

City sources said problems spiralled when top investment banks including Goldman Sachs, Lehman Brothers and Merrill Lynch - whose prime brokerage arms act as lending banks to the hedge funds - insisted that the funds settle a greater proportion of their debts at the end of the day than they had done previously. Other banks are said to have followed suit. The hike in the margin calls forced hedge funds to sell assets to cover their losses.

Comment: With the current market turmoil, Ben Bernanke faces his first big test as chairman of the Federal Reserve. The biggest favour he could do for himself and the markets is not to give in to the temptation to do favours for Wall Street or anyone else, and to remain focused on his price-stability mandate.

The US and world economies continue to grow, and, short of a genuine solvency crisis, inflation should remain the Fed's chief concern. To that end, whatever short-term liquidity is needed now to keep the markets orderly deserves to be withdrawn when conditions normalise. Letting the markets know that there is no Bernanke Put will also help bring the markets' risk appetites back into line.